Most equity markets eked out positive returns in April, supported by better-than-expected corporate earnings in the United States, and nascent signs of economic recovery in Europe. Investor sentiment remained challenged, however, due to investor fears of an economic slowdown in China and continued geopolitical tensions in the Ukraine. For the month, the Standard and Poor's (S&P) 500, Russell 1000, Russell 2000, MSCI EAFE, and MSCI Emerging Markets Indices returned 0.74%, 0.47%, -3.88%, 1.45%, and 0.33%, respectively. From an investment-style perspective, large-capitalization stocks outperformed their small-capitalization counterparts, and value stocks outperformed growth stocks with the Russell 1000 Value Index returning 0.95% while the Russell 1000 Growth Index was flat for the month. Looking at sector performance, Energy, Utilities, and Consumer Staples were the top-performing sectors, while Health Care and the more cyclical Financials and Consumer Discretionary sectors lagged.

...but equities found support in U.S. corporate earnings reports.

After weaker economic data contributed to an initial pull-back at the start of the month, equities found support in U.S. corporate earnings reports. At the time of this writing, 76% of companies in the S&P 500 have reported earnings, with approximately 71% beating estimates and reporting earnings growth of 1.7% on a year-over-year basis. Importantly, top-line growth has also been evident, with reported revenues growing 2.6%, a marked improvement from the first quarter. While a lot of earnings commentary pointed to the weather as the reason for sluggish first-quarter growth, another important theme during earnings season was the acceleration of merger and acquisition (M&A) activity as companies continued to take advantage of low borrowing costs and plentiful capital, combined with a better economic outlook. With a flurry of M&A deals in April, particularly in the Health Care and Pharmaceuticals sectors, worldwide M&A volume surpassed $1 trillion in 2014, reaching this level at the fastest pace in seven years.

U.S. macro-economic data showed signs of rebounding as the month wore on...

U.S. gross domestic product grew at an anemic annualized rate of 0.1% in the first quarter, impacted heavily by the extreme weather and coming in well below the consensus forecast of 1.2%. Housing data was similarly disappointing, although investors largely attributed the recent softness in U.S. macroeconomic data to harsh winter weather. Economic data began to rebound in late April with reports of rising consumer confidence, better-than-expected retail sales, and a strong jobs report that showed the unemployment rate dropping to 6.3%, the lowest level since September 2008. In the context of the marginally improving jobs and consumer-spending picture, the Fed announced a decrease in the pace of its bond buying program by $10 billion per month, to $45 billion.

...and the European Commission increased their growth forecast...

In Europe, economic indicators showed signs of a tepid recovery taking hold. The Eurozone Markit Manufacturing PMI advanced further into expansion territory, with activity rising in all eight of the countries polled for the first time in more than six years.1Additionally, the European Commission increased their growth forecast for the European Union this year to 1.6% from the 1.5% forecast made in late February. Despite a more positive growth outlook, risks exist from the potential disruption of oil and gas supplies should tensions escalate between the Ukraine and Russia.

...but China's economic growth continued to slow.

China's economy continued to exhibit signs of a slowdown, with an annualized GDP growth rate of 7.4% in the first quarter, which was slightly higher than forecast but down from the prior quarter's 7.7% growth rate. Data released during the month also indicated further slumps in both exports and imports, while the China HSBC Manufacturing PMI remained in contraction territory for the fourth consecutive month. A potential "hard landing" in China is of particular concern given that its economy is the second largest globally. With China's widely inflated property values, a property-bubble burst could serve as a catalyst for a hard landing that could send noticeable ripple effects into the financial markets. With Russia heading into recession, and Brazil's growth compromised by a slowdown in the commodity cycle, the BRIC nations may show less market leadership in driving emerging-market growth.

Outlook

We continue to believe that this economic cycle will be more protracted than usual given the depth and severity of the financial crisis that preceded it. Consistent with that, and recognizing that this protracted cycle will continue to be characterized by very slow rates of improvement, we think the U.S. economy has recovered and is now going through an expansion phase. What this may mean going forward is that economic growth may continue to be slower than usual for this stage in the cycle, but it should still prove robust.

The U.S. Federal Reserve will continue to focus on maintaining positive economic growth in the U.S. and will adjust the pace of its QE tapering accordingly. As we have maintained for some time now, a key consideration in the Fed's strategy remains the U.S housing market, which is a key component of U.S. economic growth. In view of this, we do not believe we will see much interest-rate volatility in the near term. Having said that, time will continue to work against low rates as the long-term trajectory has nowhere else to go but up.

Our concern is that the rate of price-to-earnings multiple expansion over the past several quarters may not be sustainable, which may negatively impact investor sentiment and dampen stock market returns. We do think, however, that there is still room, albeit not as ample, for further multiple expansion.

This commentary represents the opinions of the author as of 5/9/14 and may change based on market and other conditions. These opinions are not intended to forecast future events, guarantee future results, or serve as investment advice. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Investment Management, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information. Calvert may have acted upon this research prior to or immediately following publication. In addition, accounts managed by Calvert Investment Management, Inc. may or may not invest in, and Calvert is not recommending any action on, any companies listed.

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